When you hear a reference to the federal Employee Retirement Income Security Act (ERISA), it typically brings to mind employee retirement and insurance plans. But, as one employer was reminded by the 9th Circuit Court of Appeals, which includes California, it also applies to severance plans. This means you need to be careful when denying benefits under severance plans or risk costly federal litigation and reversal by a court.

Company Takeover Leads to Severance Plan

“Hendricks” was employed by Sunnyvale-based Verity, Inc., as a senior vice president for operations in Europe, the Middle East, Africa, and Asia. In anticipation of a possible acquisition, Verity created a severance plan that provided that if a plan participant experienced a “covered termination” following a change in the control of the company, the participant would receive certain benefits, such as cash severance and continued medical benefits. The plan defined “covered termination” as either an involuntary termination without cause or a voluntary termination “after a substantial reduction in the participant’s duties or responsibilities.” The latter situation was labeled a “constructive termination.”

The plan also provided that an employee would not receive plan benefits if he or she was offered “immediate reemployment” after a change in ownership, defined as “uninterrupted employment such that the employee does not suffer a lapse in pay.”

Employee Seeks Severance Benefits

After Verity was acquired by Autonomy Company, Hendricks was told he was at risk of termination if a suitable alternative job wasn’t identified. On January 5, 2006, “Kluger,” Autonomy’s chief operating officer, informed him that a similar position was unlikely. Hendricks’s e-mail access was terminated later that day, but he continued to receive his base salary for the next few months. On March 23, 2006, Kluger sent Hendricks a letter alerting him about an alternative position at a company controlled by Autonomy.

Hendricks subsequently sought a determination from the Verity plan administrator that he was entitled to benefits under the severance plan. Kluger, now acting as plan administrator, denied the benefits because Hendricks:

• Had been offered immediate reemployment,
• Did not suffer a constructive termination,
• Had not confirmed in writing that he would be subject to Autonomy’s confidentiality and noncompete agreements, as the plan required, and
• Had not executed a waiver and release of claims against Autonomy, as the plan required.

Courts: Employee Entitled to Benefits

Hendricks filed a lawsuit against Verity and the plan, claiming he was entitled to benefits because he had been constructively terminated. The district court ruled in his favor, and Verity appealed. The 9th Circuit also ruled for Hendricks, citing the reasons given by the district court word for word.

The district and appellate courts found that the immediate reemployment provision of the severance plan had to be read together with the constructive termination provision. Therefore, a participant would only be ineligible under the immediate reemployment provision if the new job didn’t lead to a substantial reduction in duties or responsibilities. After all, if the provisions were read separately, a participant would be ineligible for benefits if his position was changed from senior vice president to janitor, as long as the shift was immediate and he or she suffered no lapse in pay. Instead, the immediate reemployment provision applied only when the new position fell outside the definition of constructive termination—and that wasn’t the case here.

In his former position, Hendricks managed more than 100 employees and oversaw operations that generated approximately $50 million in revenues. In the alternative job, he would have been in charge of about $5 million in revenues and only 15 employees. He also would have reported to a general manager rather than to the CEO, as he had done at Verity. Kluger’s determination that Hendricks would not have suffered a substantial reduction in his duties or responsibilities, the courts found, was unreasonable.

The courts also dismissed Kluger’s other bases for denial—Hendricks’s failure to confirm in writing that he would be subject to confidentiality and noncompete agreements and to execute a waiver and release of claims. These were preconditions to actually receive benefits, not to be eligible for them. As such, he did not need to satisfy the preconditions until the employer agreed to pay the benefits. Sluimer v. Verity, Inc., U.S. Court of Appeals for the 9th Circuit, No. 09-15128 (2010).

How to Avoid a Court Reversal

Generally, if an ERISA plan gives the plan administrator discretion to make benefit determinations, courts will defer to the administrator if the decision was based on a reasonable interpretation of the plan’s terms and was made in good faith.

Practice Tip

If an ERISA plan administrator has a conflict of interest—such as both determining whether an employee is eligible for benefits and serving in a high-level position with the entity that would pay the benefits—a court will take that into account when determining whether the administrator abused his or her discretion when denying benefits.